For example, managers might enact highly visible policies that make

themselves look good and thus insure promotions. Managers might be

more interested in expensive perquisites (perks), such as beautifully
decorated offices, luxury cars, and memberships in exclusive country
clubs, than in reducing costs.

The problem is that the stockholders have no way of knowing whether

or not they are doing their best to maximise the owners’ wealth. Only in
the case of owner-managed firms can we expect the objectives of the
owners and the managers to coincide perfectly.

This difficulty has been called the principal-agent problem. The

manager is an agent of the shareholders (the principals), making
decisions on their
behalf. It is theoretically possible for stockholders to evaluate the managers’
efforts by establishing an elaborate and costly intelligence system to monitor
the managers’ actions. In reality, of course, the stockholders’ interests lie in
avoiding such costs. Some agency theorists hold that monitoring
management action is unnecessary. They point to empirical data that show a
strong relationship between a company’s profitability and executive
compensation and offer these data as proof that market dynamics are
sufficient to lead managers to give their best effort.